Todd Davison, Director Purbeck Insurance Services offers tips on the facts to check when raising finance through a personal guarantee backed loan
Additional funding can help businesses scale up, aid cash flow and may help to offset downturns in trade or disruption within the supply chain. However additional funding usually comes at a price.
In the case of commercial loans, it’s not just a signature required on the line; many loans require a personal guarantee, putting personal assets on the line too.
While many businesses turn to overdrafts or unsecured business loans, recent research of SMEs commissioned by Purbeck Insurance Services found that 32% of enterprises with turnover between £1 million and £99.99 million who have taken out business finance were required to sign a Personal Guarantee. Nearly a third (29%) of those businesses turning over £1-9.99 million had to sign a Personal Guarantee.
The research also revealed there is a lot of misunderstanding surrounding Personal Guarantees. Just over 60% of all respondents didn’t realise the finance provider will be able to repossess the personal assets of business owners or directors if the loan is called in for payment. And this misconception was common across all business sizes.
A Personal Guarantee gives the lender a written promise, made by a director or number of directors, to accept liability for a company’s debt. In practice, this means that if the business defaults on a loan (or lease) the director’s home, car and anything in their personal bank account may be at risk.
A spouse or partner often has to sign the guarantee if they co-own the family home and/or other assets, and most guarantee forms require joint and several liability. This means each individual who signs a guarantee can be liable for the whole amount of the loan.
It’s therefore vital that firms seek sound financial and legal advice so that they fully understand the risks involved before making such an important commitment. It also makes sense to research ways the risk can be mitigated, such as taking out personal guarantee insurance.
Lenders really do call in guarantees and directors may be placing all of their assets at risk, including their home if things don’t go according to plan.
The finance provider should always ask the spouse or partner of a director, or any other person who is being asked to give the Personal Guarantee, to obtain independent legal advice before signing the loan agreement. In addition, should a loan be called in, it is advisable to take legal advice; while it is rare for a finance provider to not follow its own procedures, it’s always worth checking.
How will the lender enforce the Personal Guarantee?
There are several options open to creditors to enforce a Personal Guarantee. One frequently used is for the creditor to apply for a County Court/High Court Judgement. They can either get a Warrant of Execution and get the bailiffs in, or they go for a Charging Order to secure the debt against the borrower’s home.
Very often a lender will engage a third party debt collection agency. And it’s worth noting that usually the debt collection agency fees will be added to the outstanding balance of the loan.
Can the lender serve notice or seek payment on demand?
Depending on the creditor and the amount being called on, the usual final route is for the creditor is to issue a Statutory Demand and give 21 days for the debtor to either settle the debt or reach an agreement to pay. However creditors are more or less generous with their payment terms, and can seek payment on demand.
What exactly constitutes a default?
Just 24 hours late on a payment may not feel like ‘late’ to some. But many loan providers will see this as a default and take steps accordingly to recoup the debt or for default on the payment.
Do the terms allow for any remedy period upon default?
Some creditors do allow a specified timeframe for a default on a loan payment to be repaid – others are less flexible. But regardless of the lender’s approach, it will usually cost the business. This may be in the form of adding interest, for example of 0.5% or more, to the debt for each day a payment is outstanding.
Lenders may also charge for each attempted contact they make with a debtor, when they consider the loan has defaulted. For instance, some providers will charge £20 each time they try to contact a debtor by telephone or £10 for each email sent after any payment default. If two consecutive payments are missed then a letter may be sent via recorded delivery – and that will incur a cost too.
How will a Director’s net personal assets be assessed prior to the giving of the guarantee, and is this likely to change?
Many providers of personal guarantee loans ask for a personal financial statement. The format is standard and shows assets and liabilities. Others may require more proof of the value of a Director’s assets, such as an independent valuation report from an expert.
Does the contract state the lender must exhaust every other avenue before making demands on the debtor?
Some lenders are prepared to look at business assets before calling in the whole debt. But if a Personal Guarantee has been signed, then it shouldn’t be unreasonable to expect the lender to consider the Director’s personal assets too.
Mitigating the risk
Given the level of action that a lender could take if a business defaults of a loan which has been secured with a Personal Guarantee, it makes sense to consider steps that could reduce that risk. One option is to consider Personal Guarantee insurance. This will offset any outstanding obligations.
The level of cover is based on a fixed percentage of the Personal Guarantee the company director wishes to insure and this is dependent on whether the corresponding finance facility is secured or unsecured.
500 SMEs surveyed by Censuswide – March 2019